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Last week, a divided SEC adopted controversial new rules for credit-rating agencies to set up review and disclosure requirements and add safeguards to prevent sales and marketing considerations from influencing the ratings, reports National Law Journal.

 

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As noted by National Law Journal, rating agencies such as Standard & Poor's and Moody's were blamed in the wake of the financial crisis for giving high ratings to toxic residential mortgage-backed securities. In fact, the Justice Department is currently embroiled in a lawsuit against Standard & Poor's in U.S. district in Santa Ana, California, based on DOJ allegations that S&P inflated its ratings to win more fees from customers and failed to downgrade bad securities in a timely fashion.

 

Reviews from within the SEC are mixed. SEC Chairwoman Mary Jo White hails the new rules as "creat[ing] an extensive framework of robust reforms," adding that "this package of reforms will improve the overall quality of [credit ratings] and protect against the re-emergence of practices that contributed to the recent financial crisis." But Commissioner Daniel Gallagher, a Republican, says that "the last-minute imposition of ill-conceived and hastily drafted rule provisions" will create "a terrible, dangerous precedent that I am sure we will soon come to forget." And Commissioner Michael Piwowar argues that the new rules represent SEC overstepping, making "discretionary changes ... that go well beyond the prescriptions of the Dodd-Frank Act."

 

So what are the new rules? Here are the highlights, as reported by National Law Journal:

 

  • The new rules require credit-rating agencies to "establish, maintain, enforce, and document an effective internal control structure" for determining ratings, including regular review and allowing market participants to comment on whether the rating methodology should be updated.
  • The new rules bar any credit-rating agency employees, including senior managers, who "participate in sales or marketing of a product or service" to determine or monitor credit ratings or to be involved in developing the methodology used to set the ratings. National Law Journal reports that Gallagher characterized this provision as "a novel approach of establishing what amounts to a thought crime ... This new prohibition is solely based on statement of mind – there is no requirement that any action be taken ... I can't imagine any court in the country not striking down this vague and unverifiable 'influence' clause."
  • The new rules also require ratings agencies to conduct a "look-back" review to determine when the "prospect of future employment by an issuer or underwriter influenced a credit analyst in determining a credit rating." If so, they have 15 days to determine whether to affirm or revise the rating and to include a public explanation.
  • The new rules require that raters must publicly disclose information about their initial credit ratings and subsequent changes to the credit ratings so investors and others who rely on the ratings can evaluate the accuracy and compare the performance of credit ratings from agency to agency.

 

Stay tuned to see if the SEC's regulatory framework will help ensure investors have confidence in the ratings process or, instead, will simply impose onerous regulatory requirements on credit agencies that do not help the market.

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